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The Pricing Effects of Securities Class Action Lawsuits and Litigation Insurance

Journal of Law, Economics, and Organization, Vol. 30, No. 3, pp. 493-532, 2014

Posted: 18 Aug 2010 Last revised: 22 Aug 2014

Judson Caskey

University of California, Los Angeles (UCLA) - Accounting Area

Date Written: November 5, 2012

Abstract

The price reactions to corrective disclosures often serve as a benchmark for settlements in securities class action lawsuits. When the firm bears litigation costs, this benchmark creates a feedback effect that exacerbates the price reaction to news that contradicts managers' earlier reports. Litigation insurance provides value in this setting by reducing the need for investors to price the effects of anticipated litigation. Insurance also affects how changes in the litigation environment impact the firm, with some changes having opposite effects on the frequency of lawsuits against uninsured and insured firms. The pricing behavior of rational investors eliminates the valuation impact of the portion of settlements paid to investors, similar to dividends. The valuation impact of litigation arises from transaction costs, such as attorney fees, that the firm can mitigate by constraining misreporting and by purchasing insurance.

Keywords: Securities litigation, Litigation insurance, Earnings management, Rational expectations, Reporting bias

JEL Classification: G14, G30, K22, M41

Suggested Citation

Caskey, Judson, The Pricing Effects of Securities Class Action Lawsuits and Litigation Insurance (November 5, 2012). Journal of Law, Economics, and Organization, Vol. 30, No. 3, pp. 493-532, 2014. Available at SSRN: https://ssrn.com/abstract=1660162 or http://dx.doi.org/10.2139/ssrn.1660162

Judson Caskey (Contact Author)

University of California, Los Angeles (UCLA) - Accounting Area ( email )

D410 Anderson Complex
Los Angeles, CA 90095-1481
United States

HOME PAGE: http://sites.google.com/site/judsoncaskey/

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